Reference no: EM13874463

1. In Albrecht v. Herald Co., the Supreme Court in 1968 decided a case involving the publisher of a St. Louis newspaper and one of the carriers that delivered the newspaper to individual households. The publisher had established a system in which each carrier was granted an exclusive territory that was subject to termination if the carrier charged a retail price for the newspaper exceeding the maximum price suggested by the publisher. In 1961, the carrier for Route 99 raised the price for its customers to a level that exceeded the suggested maximum retail price. The publisher took retaliatory actions that eventually caused the carrier to lose the route, and the carrier sued for treble damages under Section 1 of the Sherman Act. The Supreme Court decided that enforcing resale price restrictions in this manner constituted per se illegal price-fixing.

To model this situation, let the inverse demand function for newspapers on Route 99 be P = a - Q, where a > 0, and Q denotes the number of newspapers sold in the route. The publisher's marginal cost of producing newspapers is a constant denoted by c, and the marginal advertising revenue per newspaper is a constant denoted by e, so the "net marginal cost" is c - e. Suppose that the carrier incurs a constant marginal delivery cost denoted by d. The carrier pays a wholesale price w and sells papers at a retail price P. Both the carrier and the publisher are profit
maximizers.

(a) Suppose that resale price restrictions could be enforced legally, so the publisher chooses the prices w and P. Give an expression for the publisher's profit. Find an expression for P and show graphically how the optimal levels w∗ and P∗ are chosen. Would the carrier prefer a retail price that is greater than or less than P? Illustrate your answer graphically.

(b) Now suppose that resale price restrictions cannot be legally enforced, so the carrier is free to choose P. Let wt and Pt denote the equilibrium prices without the resale price restriction. Will Pt be greater than or less than P∗? Find an expression for Pt and illustrate your answer graphically.

(c) Does making maximum resale prices illegal per se improve consumer welfare (in the sense of consumers' plus producers' surplus).

(d) Suppose that the carrier's demand depends on its expenditure on selling effort, s, and that it chooses s to maximize its own profit. In this case, will a resale price restriction be sufficient to achieve profits under complete contracting for the publisher?